Rent vs buy

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The Background:

It's the first of the month again. Another month down. Another rent check mailed. This has been my routine for a while now, and even though I like where I live, am I just throwing money away if I have nothing to show when my lease is up? This question crosses the mind of a lot of renters.

Buying a home is an opportunity to join a community and settle down in a permanent place. Having good credit, not too much debt, stable income, and adequate savings are signs that you could be in a financial position to choose homeownership (in addition to being emotionally ready for the responsibilities).

But is it truly better to buy? The Fidelity Viewpoints article, "Should you buy a home or keep renting?" helps make the living situation decision easier—and even includes a simple tool where you can play with the numbers for yourself.

The Breakdown:

A lot of people focus on the short term, monthly costs instead of the bigger picture when considering whether to rent or buy. But it's also important to think about how this decision could affect your overall wealth down the road. Fidelity suggests asking yourself these five questions:

1. How Long Are You Planning to Stay Where You Are?

This is an important factor in your decision because the home buying process involves upfront costs like brokers' fees, appraisal fees, title insurance, and a mortgage origination fee. The longer you plan on staying in a home, the more time you have to spread out these costs. Also if you sell quickly, your home may not have gained enough value to offset those fees. Generally if you're planning on staying less than three years, then buying won't be a good decision.

2. Do House Prices Always Go Up?

Before 2007, a lot of people assumed that home prices always rise, but that's not necessarily the case. Between 2007 and 2009, the median home price in the United States dropped nearly 13%1. It's important to consider the financial impact if your house's value increases slowly—or not at all. Also, putting a large amount of your money into a single investment—like a house—could be riskier than spreading your savings out across a portfolio of investments.

3. Are You Throwing Away Money on Rent?

One common argument used to defend buying a home is that owners are building equity that can boost their long-term wealth. On the other hand, paying a landlord each month seems like spending, rather than saving. But, buyers who hope that a home will help improve their overall financial health should make sure they're not just focusing on monthly mortgage payments versus monthly rent and ignoring the other additional costs of homeownership.

For example, putting down less than 20% usually means paying Private Mortgage Insurance or PMI, which, like rent, is money you won't get back. On the flipside, having a solid credit score could allow a buyer to get a better mortgage rate and pay less in interest. There are also other costs such as taxes, insurance, and maintenance. (Many specialists recommend budgeting at least 1% of the value of your home each year to cover routine maintenance.2)

4. How Much Will You Save on Taxes?

A lot of buyers assume that much of the added home ownership costs can be equaled out by deducting mortgage interest payments on their taxes. That's not always the case. First, to take advantage of this possible benefit, you'd need to itemize your tax deductions. Secondly, if interest rates are low, it could mean that you may not get much of a deduction. Plus, over the course of your mortgage, your deduction will decline since you'll be paying less in interest.

5. Are You Comparing Apples to Apples?

The apartment you might be renting could be very different from the one you'd buy. Is it a single family? Is there a yard? Basement? Square footage and other things like location are non-monetary benefits to consider.

Asking yourself these questions should give a clearer picture of whether you should buy or rent. You may also want to calculate the price-to-rent ratio—a common formula used to determine a home's value. (Just divide the home value by the annual rent amount). If it's less than 20, buying might be the better option. Greater than 20 and renting could be more worthwhile.

Another useful comparison is to look at the equity you could build in your home over time compared to the money you could make if you were to invest it instead of using it to purchase a house. We designed this simple tool to help you look at the long-term view of your finances.

The Bottom Line:

Before you sign a lease or buy a home, remember to consider your overall financial picture at the end of your stay, instead of basing your decision only on monthly or yearly costs.

Take the Next Step

This tool can help you decide if you should pay rent to a landlord or become a homeowner.

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Investing involves risk, including the risk of loss.
Fidelity does not provide legal or tax advice. The information provided above is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific legal or tax situation
Views expressed are as of the December 10, 2015, based on the information available at that time, and may change based on market and other conditions. The opinions provided are not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
Fidelity Brokerage Services Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
© 2015 FMR LLC.
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